Business Cycles

Empirical Properties

What do we mean by “The Business Cycle”?

Gross Domestic Product: 1947-2003

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1/1/47 1/1/54 1/1/61 1/1/68 1/1/75 1/1/82 1/1/89 1/1/96 1/1/03

Gross Domestic Product: 1947-2003

• Since WWII, Nominal GDP has grown at an average annual rate of 6.8%

Gross Domestic Product: 1947-2003

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-10-5051015202530

Level Growth

Gross Domestic Product: 1947-2003

• Since WWII, Nominal GDP has grown at an average annual rate of 6.8%

• However, we know that some of this growth is simply due to prices.

Nominal vs. Real GDP: 1947-2003

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What do we mean by “The Business Cycle”?

• Since WWII, real GDP in the US has grown an average of 3.5% per year. (The remaining 3.3% is a pure inflation effect)

Real GDP: 1947-2003

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-15-10

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510

1520

VALUE Growth

Detrending

• We can take any macroeconomic variable and break it down into 4 distinct frequencies:– Growth (Many Years)

Detrending

• We can take any macroeconomic variable and break it down into 4 distinct frequencies:– Growth (Many Years)– Business Cycle (1-2 Years)

Detrending

• We can take any macroeconomic variable and break it down into 4 distinct frequencies:– Growth (Many Years)– Business Cycle (1-2 Years)– Seasonal (Months)

Detrending

• We can take any macroeconomic variable and break it down into 4 distinct frequencies:– Growth (Many Years)– Business Cycle (1-2 Years)– Seasonal (Months)– Noise (< Month)

Detrending

• Before we can do any statistical tests, we must remove the growth component from the data (note: the seasonal component has already been removed)

• However, to do this, we need to know what the what the growth component is……this is very tricky! (Example: Global Warming)

Hypothesis 1: Linear Growth

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Hypothesis 1: Linear Growth

y = 38.447x + 549.74R2 = 0.9597

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Detrended?

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Level Deviation

Stationary Series

• If we have detrended properly, then the residual should be stationary (i.e. constant over time)

• While there are statistical tests to determine stationarity, we will rely on the “eyeball method”!

Hypothesis 2: Exponential Growth

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Hypothesis 2: Exponential Growth

y = 1644.6e0.0083xR2 = 0.9946

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Deviations From Trend

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What do we mean by “The Business Cycle”?

• Since WWII, the US has experienced 11 recessions (followed by 11 expansions).

What do we mean by “The Business Cycle”?

• Since WWII, the US has experienced 11 recessions (followed by 11 expansions).

• The average contraction lasts 11 months while the average expansion lasts 15 months.

What do we mean by “The Business Cycle”?

• Since WWII, the US has experienced 11 recessions (followed by 11 expansions).

• The average contraction lasts 11 months while the average expansion lasts 15 months.

• Empirically, each of these recessions (and expansions) look “similar”

Characteristics of Business Cycles

• When we say that all recessions/expansions “look similar”, we mean that there seem to be consistent statistical relationships between GDP and the behavior of other economic variables.

Characteristics of Business Cycles

• When we say that all recessions/expansions “look similar”, we mean that there seem to be consistent statistical relationships between GDP and the behavior of other economic variables.

• Correlation (procyclical, countercyclical)

Characteristics of Business Cycles

• When we say that all recessions/expansions “look similar”, we mean that there seem to be consistent statistical relationships between GDP and the behavior of other economic variables.

• Correlation (procyclical, countercyclical)

• Timing (leading, coincident, lagging)

Characteristics of Business Cycles

• When we say that all recessions/expansions “look similar”, we mean that there seem to be consistent statistical relationships between GDP and the behavior of other economic variables.

• Correlation (procyclical, countercyclical)

• Timing (leading, coincident, lagging)

• Relative Volatility

% Deviations From Trend

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GDPInvestment

% Deviations From Trend

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GDPInvestment

GDP vs. Investment

• Std. Dev. (Y) = 4.09

• Std. Dev. (I) = 10.92

• CORR(Y,I) = .55

GDP vs. Investment

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CORR

GDP vs. Investment

• Std. Dev. (Y) = 4.09

• Std. Dev. (I) = 10.92

• CORR(Y,I) = .55

• Investment is Procyclical and is Coincident with GDP

% Deviations From Trend

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%G

-6-5-4-3-2-101234

%Y

Govt GDP

GDP vs. Government Purchases

• Std. Dev. (Y) = 4.09

• Std. Dev. (G) = 11.2

• CORR(Y,G) = .58

GDP vs. Government Purchases

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CORR

GDP vs. Government Purchases

• Std. Dev. (Y) = 4.09• Std. Dev. (G) = 11.2• CORR(Y,G) = .58

• Government Purchases is Procyclical and Leading